Already a member?

Market Update: Can An Extended S&P 500 See Further Gains?

The "sell in May" chorus is coming back, but I am prepared. For
the last few weeks, I have been examining the potential for a
summer slump in the S&P 500 ( SPY ) by looking at
four indicators: unemployment, Federal Reserve policy, Europe and
S&P 500 earnings. These were the catalysts for the correction
last summer, but they are in better shape this year. There is no
denying that economic growth is sluggish and the S&P 500's
valuation is extended relative to the last few years (but not the
last few decades). However, an extended market can still generate
further gains before correcting. Under the surface there are
pockets of strength and weakness and that is not necessarily a
reason for a sell-off either. In this article, I will look at the
performance of the S&P 500 and discuss if the summer slump
indicators are supporting or resisting further gains for the
S&P 500.

S&P 500 Performance

The S&P 500 is again approaching new highs and rebounded
nicely from the weakness following the big drop in gold ( GLD ) on April 15.

On a multi-year timeframe, the S&P 500 may seem extended.
The current rally from the November lows is outpacing the rally
going into Q1 2012 and the S&P 500 has gone a few months
without a pause.

(click to enlarge)

(Source: FreeStockCharts.com)

It is important to consider sentiment when examining the S&P
500's run to new highs. It still seems like many investors are
bearish. The year started with many investors scared of the fiscal
cliff and the disappointed with a second term for Obama. Since
then, the S&P 500 has rallied and there hasn't been a
meaningful pullback that the bears have been looking for.
Furthermore, the few times that the S&P 500 dropped a couple of
percentage points, dip buyers came in and were rewarded.

It seems like many investors have capital on the sidelines and
are waiting for a big pullback to get in the market. With the
absence of a negative catalyst, that kind of sentiment could drive
more gains as the reluctant investors eventually give up and start
to chase the market.

This outlook assumes no negative catalyst, which is why I
examine the summer slump indicators every week. A negative catalyst
may arise from the many macro events this week (Fed meeting, ECB
meeting, jobs number), but I continue to be bullish on the S&P
500 until one shows up.

Summer Slump Indicators

The following is a summary of how I view the indicators
discussed below. If a box is left blank that means that there was
not enough "new news."

(click to enlarge)

This is just my view. I am interested in hearing other opinions,
so please feel free to give feedback in the comments section
below.

Jobs

The April nonfarm payroll report will be released on Friday.
Following the disappointing number in March, the April number will
be important in establishing if there is a trend of weakness on the
jobs front or if March was an outlier. Here is the data for the
last few years:

(Source: BLS.gov)

The weekly jobless claims are too volatile to serve as a good
indicator, but they showed some improvement last week:

"In the week ending April 20, the advance figure for
seasonally adjusted initial claims was 339,000, a
decrease of 16,000 from the previous week's revised figure of
355,000. The 4-week moving average was 357,500, a decrease of 4,500
from the previous week's revised average of 362,000."(Source:US Department of Labor)

Federal Reserve

The FOMC is scheduled to meet on Tuesday and Wednesday.
Expectations call for an uneventful Fed meeting. A few weeks ago,
there was talk about the Fed "tapering" down its $85 billion of
monthly bond purchases, but since then, the economic data has been
weak: disappointing job growth in March and disappointing Q1 GDP
growth. Furthermore, falling commodity prices are weighing down
inflation and some FOMC members think that inflation is too
low.

The economic data is producing a "Goldilocks" moment for the Fed
and investors. The economy is recovering and unemployment is coming
down, but the growth rate is below expectation. The economy is
doing well enough to provide some growth, but not that well that
the Fed would end QE sooner rather than later.

Likewise, the fall in commodity prices is good for many parts of
the economy, but is also providing the Fed more reasons to continue
QE.

I expect the Fed will continue with quantitative easing until,
at least, Ben Bernanke finishes his term as Fed chairman in January
2014. This implies that the Fed's balance sheet would grow to
approximately $4 trillion, from the current $3.2 trillion. The
S&P 500 has performed well during previous periods of QE and I
expect a similar performance now.

Europe

Expectations are growing for the ECB to cut interest rates at
its meeting on Thursday.

The ECB has held off cutting rates longer than many expected.
The European bond markets rallied and recovered well from the
Cyprus crisis. Despite the ongoing economic malaise, there does not
seem to be a imminent catalyst for a rate cut. Furthermore, Mario
Draghi has repeatedly said that the ECB has a limited ability to
deal with economic weakness in the Eurozone and that it is up to
fiscal authorities to act.

However, there are many ECB watchers that follow it much more
closely than me. Many of them think that a rate cut could be
coming. Therefore, I don't have a prediction.

Putting aside ECB rate cut speculation, there is no denying that
the European capital markets are doing better, even if the economy
is weak. The European sovereign bond markets have been rallying
since the Draghi Put last summer and the rally continued after a
brief pause for the Cyprus crisis.

Over the last few days, European equity markets started to
rebound.

If the ECB does not cut rates, the European bond and equity
markets may give back some of the recent gains. At best, Europe may
stage a comeback. At worst, Europe is stable (for now). But, Europe
does not seem like a negative catalyst for the S&P 500 like it
was last summer.

There have been some earnings disappointments from bellwether
companies in the S&P 500, such as General Electric ( GE ) and IBM ( IBM ), but the
aggregate numbers look good so far. There are a lot more earnings
reports to come, so it is still too early to tell how Q1 earnings
season will turn out.

Banks

As I mentioned last week, the banks delivered good, but not
great, Q1 results. This was in-line with my expectations.

The market reaction is more important than the actual numbers
and, so far, bank stocks have held up well. Many of these stocks
rallied going into Q1 earnings, so I was not expecting an immediate
move higher, but I wanted to see if the Q1 results would be good
enough to allow the banks to hold on to their previous gains.

So far, so good, as seen in the performance of the Financial
Select Sector SPDR® Fund ( XLF ). The XLF is back
up to multi-year highs dating back to the financial crisis.

(click to enlarge)

(Source: FreeStockCharts.com)

Apple

Apple (AAPL) is important for two reasons: it is the second
largest component in the S&P 500, representing 2.78% of the
index, and it is a widely watched stock that is significant for
investor sentiment.

Although analysts and pundits reacted negatively to Apple's Q1
earnings report, I thought it was pretty good. Despite the negative
reaction, Apple's share price has rebounded since the earnings
report. Maybe this is a bottom in negative sentiment.

(click to enlarge)

(Source: FreeStockCharts.com)

The initial stock market reaction to Apple's earnings was
positive, but it will be important to see if there is
follow-through and if the reaction to the reaction is also
positive.

Tech

Big tech earnings have been weak, especially from companies that
have exposure to the federal government. With the sequester
curtailing government spending and sluggishness in Europe, tech
companies face challenges in two important markets.

Following earnings disappointments from Oracle (ORCL), Tibco
(TIBX), Fortinet (FTNT) and IBM , Riverbed (RVBD) just came out
with weak results.

However, there are some pockets of strength in the tech space.
Google (GOOG) reported good Q1 results and its stock moved up on
the news. Surprisingly, Intel (INTC) and Microsoft (MSFT) are
trading up despite the problems that they face in the PC space.

Despite the problems in the tech sector, the Nasdaq (QQQ) is
performing well. Although the Nasdaq is lagging the S&P 500
year-to-date, it is also rallying to multi-year-highs.

(click to enlarge)

(FreeStockCharts.com)

Materials

The metals/mining sector has been the most obvious pocket of
weakness during the recent rally. Last week, Caterpillar (CAT)
released Q1 earnings and its commentary about the mining industry
was not encouraging.

However, the materials sector has been performing better. I had
been lumping the metals/mining sector together with the materials
sector in these updates, but it is important to distinguish between
the two.

The following charts show the one year performance for the SPDR®
S&P® Metals and Mining ETF (XME) and the Materials Select
Sector SPDR® Fund (XLB).

The metals/mining sector is clearly lagging, but not all
cyclicals are weak. In fact, Du Pont (DD) spiked up to multi-month
highs following Q1 earnings.

Conclusions

The S&P 500 is approaching new highs. Many investors seem to
be hesitant about the market, but the S&P 500 does not need to
top out just because it is at new highs and its valuation is a bit
extended.

Last year, there were four main reasons for a 10% correction,
but these factors seem to be in better shape now. There is a lot of
macro data coming this week that could change the situation, so I
am keeping a close watch and will update this analysis next week
too.

There are pockets of strength and weakness in the market, but
the S&P 500 has been resilient. In aggregate, Q1 earnings for
companies in the S&P 500 look good and the problems in certain
sectors (metals/mining and some areas of tech) are not serving as
catalysts for broader declines.

The S&P 500 cannot rise forever and will experience a
correction at some point. But, I wonder if the lack of negative
catalysts and the abundance of capital on the sidelines will fuel
further gains and delay the eventual pullback.

Disclaimer: The opinions
expressed above should not be construed as investment advice. This
article is not tailored to specific investment objectives. Reliance
on this information for the purpose of buying the securities to
which this information relates may expose a person to significant
risk. The information contained in this article is not intended to
make any offer, inducement, invitation or commitment to purchase,
subscribe to, provide or sell any securities, service or product or
to provide any recommendations on which one should rely for
financial, securities, investment or other advice or to take any
decision. Readers are encouraged to seek individual advice from
their personal, financial, legal and other advisers before making
any investment or financial decisions or purchasing any financial,
securities or investment related service or product.

Information provided, whether charts or any other statements
regarding market, real estate or other financial information, is
obtained from sources which we and our suppliers believe reliable,
but we do not warrant or guarantee the timeliness or accuracy of
this information. Nothing in this article should be interpreted to
state or imply that past results are an indication of future
performance.

THERE ARE NO WARRANTIES EXPRESSED OR IMPLIED AS TO ACCURACY,
TIMELINESS, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION
IN THIS ARTICLE OR ANY LINKED WEBSITE.

Disclosure: I am long [[AAPL]], [[IBM]],
[[GOOG]]. I wrote this article myself, and it expresses my own
opinions. I am not receiving compensation for it (other than from
Seeking Alpha). I have no business relationship with any company
whose stock is mentioned in this article.

Additional disclosure: I may trade any of the
securities mentioned in this article at any time, including in the
next 72 hours.

Please note that once you make your selection, it will apply to all future visits to NASDAQ.com.
If, at any time, you are interested in reverting to our default settings, please select Default Setting above.

If you have any questions or encounter any issues in changing your default settings, please email isfeedback@nasdaq.com.

Please confirm your selection:

You have selected to change your default setting for the Quote Search. This will now be your default target page;
unless you change your configuration again, or you delete your
cookies. Are you sure you want to change your settings?